An analysis of initial public offering ( ipo ) underpricing on smes firms performances

The study of initial public offering (IPO) underpricing and its post-listing underperformance has been one of those issues that are never laid to rest. The ongoing quest for the reasons behind IPO underpricing and its subsequent poor post-listing returns is what motivates this paper to study these anomalous market behaviors in an emerging market setting such as Malaysia. The primary purpose of this paper is to analyze the existence and magnitude of the underpricing phenomenon and post listing performance of IPOs listed in Bursa Malaysia from 1998 to 2008. Moreover, this study aims to provide an insight primarily into the relationship between IPO initial and long-term stock performance and the four main determinants influencing underpricing, namely IPO size, market volatility, underwriter status and reciprocal of IPO price. By analyzing a sample of 313 IPOs, the average market adjusted initial return is 9.4%. The regression-based analysis indicates positive relationship between underpricing and the explanatory variables, namely IPO size, market volatility, underwriter status and reciprocal of IPO price. In addition, the findings of the present study lend support to the evidence of a fads hypothesis as the sample IPO was found to under-perform the market over a 36-month period after listing and the univariate regression analysis further reveals that there is a negative relationship between initial market adjusted returns and returns over the 36-month period. Introduction Initial Public Offerings (IPOs) underpricing i.e., a positive gain of a new stock on the listing day compared to its IPO offer price is a commonplace phenomenon in many markets. The dominance of positive first day returns for IPOs has puzzled finance academics for decades. A large body of finance literature has proposed various models and hypotheses to explain this so-called underpricing phenomenon. In other words, on average, an investor who subscribes new IPO issues at the offer price and sells them at the closing price on first day can make positive returns. The investigation of IPO pricing and performance is one of those market anomalies that continuously attract the attention of many researchers in finance. Several theories have been put forward to argue that underpricing of IPO is an equilibrium occurrence in an efficient capital market. In fact, to a certain extent, deliberate IPO underpricing by the issuers and underwriters is needed for different reasons. It is understandable that if the IPO subscription price is set at a lower valuation than the expected valuation of new shares, then IPO subscribers would be able to earn a positive rate of initial return on the first trading day upon listing. The short-run and long-run performances of IPOs are the most frequently research topics on IPO studies which gives rise to a vast body of empirical research on the two main anomalies in IPOs. There are two well-known findings that have been the focus of substantial theoretical and empirical research in the IPO literature for many years. Firstly, it is the presence of underpricing in IPOs. Investors who subscribe for IPO shares and sell them during the first day of trading earn a positive return where closing price on the first day of trading is higher than the offering price. Secondly, new stocks generally decline or underperform the market for three to five years following the offering date. Investors who buy IPO shares at the end of the first trading day will earn a long-run return far less than that of comparable stocks. These two persistent anomalous behaviors that characterize IPOs—the first-day underpricing and the long-term underperformance of certain IPOs—have intrigued academics and scholars over the past two decades and have generated considerable research aimed at providing explanations and reasoning behind this phenomenon. This anomalous behavior is observed in many countries. Ritter (1984, 1991), has confirmed the existence of IPO underpricing in the United States. This is surprising when it is a fact that underpricing can be very costly to company shareholders, in that the 'money left on the table' amounts to billions of dollars. From the 1960s onwards, the price discount has averaged around 19%. However, the price discount fluctuated considerably, achieving an average of 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 21% in the 1990s and 40% in the 4 years since 2000 (Ljungqvist, 2005). The level of underpricing was even more evident in the late 1990s and in the beginning years since 2000, where market sentiment was bullish with the Internet IPO boom. This study is exploratory in nature and investigates whether there is an existence of underpricing for IPOs listed on the Kuala Lumpur (KL) Bursa Main Board or KLSE from the year 1998 to 2008. Although there is a great deal of research that investigates these issues in most developed countries stock markets, only a few studies have been undertaken in the developing Malaysian context, particularly in the aftermath of Asian financial crisis that gripped much of the Asian region in 1997. Hence, this paper [Khin et al., 3(6): June, 2016] ISSN: 23495197 Impact Factor (PIF): 2.138 INTERNATIONAL JOURNAL OF RESEARCH SCIENCE & MANAGEMENT http: // www.ijrsm.com (C) International Journal of Research Science & Management [22] aims to examine the initial and long-run performance of IPOs listed in the KL Bursa from the period 1 January 1998 to 31 December 2008. The aim of this research paper is to provide an empirical review of short run and long-run performance of IPOs. The objectives of this study are: 1. To investigate the evidence IPO underpricing 2. To analyze the initial and short run performance of IPOs 3. To analyze the long-term performance of IPOs subsequent to listing 4. To investigate four main possible determinants for IPO underpricing Below, we review the literature and develop related hypotheses regarding the possible explanations for IPOs performances. The sampling design, selection of measurement scales and data analysis techniques are then described, and this is followed by a presentation and discussion of results, study limitations and possible future research. Literature review The short run underpricing of IPOs Most companies that go public do so via an initial public offering (IPO) of shares to investors. The issue of underpricing in IPO has been an extensive field for investigation in the financial community, especially during the last decade. This underpricing phenomenon has garnered enormous interest among the financial economists for many decades. In the early days, some studies focus on some specific factors in explaining the underpricing phenomenon. Early researchers such as Logue (1973) and Ibbotson (1975), documented that when companies go public, the IPO shares tend to be underpriced, in that the share price jumps on the first day of trading. This means that an investor who purchases new issues at the offering price and sells them at the closing price on the first day of listing is able, on average, to make relatively large return. Using the data from 1990 till 1998, Loughran and Ritter (2000) found that initial returns on IPOs averaged about 15 percent which was equivalent to approximately USD27 billion of potential IPO proceeds that were ‘left on the table’ as a result of underpricing. More recently, another observation by Ritter (2001) documented that during the two-year period from 1999 to 2000, about USD65 billion was ‘left on the table’ from the IPOs raised. Jelic, Saadouni and Briston (2001) using 182 IPOs on the KLSE Main Board over the period January 1980 to December 1995 documented that the degree of underpricing appeared to be exceptionally evident during the ‘hot issue’ periods of 1983-1985 and 1993-1995. In a Koh and Walter (1989) study, 66 IPOs in Singapore Stock Exchange during 1973 to 1987, their tests reveal similarities with the major findings of Rock’s (1986) model whereby there is a significant positive correlation between the oversubscription level and first day returns. In Singapore, if the IPOs are oversubscribed, all subscribers of a particular size have an equal chance to purchase shares. This allocation process makes the calculation of the probabilities of obtaining an allocation conform with Rock’s model. Furthermore, they also found that underpricing is more prevalent among large investors than small ones. Levis (1990) demonstrates that the underpricing of IPOs can be accounted for by the “winner’s curse” problem and interest rate cost in his studies on 123 IPOs in London Stock Exchange from the period January 1985 to December 1988. After the allocation rate and interest rate cost is taken into account, the first day return is not significantly different from zero. Keloharju (1993) studies 80 IPOs in the Finnish market from 1984 to 1989. His evidence confirms the existence of the “winner’s curse” where there is a significantly negative relation between allocation rate and first day return. The degree of underpricing varies significantly across markets. Loughran et al. (1994) provides an international survey of IPO performance in 25 countries, including 7 regional countries with an average initial return of 78.1% for Korea; 32.5% for Japan; 17.6% for Hong Kong; 80.3% for Malaysia; 27.0% for Singapore; 58.1% for Thailand and 45.0% for Taiwan. From their investigation, they conclude that the move by East Asian economies to reduce regulatory intervention in fixing IPO subscription prices should result in less underpricing of IPOs in the 1990s compared to the 1980s. Ritter (2003) reports that the average initial returns experienced in Asian IPOs are significantly higher than the average initial returns of U.S. IPOs. For example, his research shows that the average initial return of new listings in 33 countries ranged from 13.6% to 388% in the developing market and 4.2% to 54.4% in developed markets. In addition, he also reports the extent